On Traders And Ants

Includes: GLD, GLL, SPY
by: Itinerant

Commentators sometimes compare the stock market to a line of ants. Running a stick through this line causes some brief confusion among the insects. After a little while the ants will resume their activities in the exact same manner as before.

The argument goes that trading is governed by sentiment. Various news items can cause a brief disturbance but cannot override trading patterns. Last week's musings about the timing of tapering created such a short-time distraction as shown in the attached chart. Fed heads spoke, caused some commotion among traders, but soon thereafter the stock market marched on as if nothing had happened.

And where is this line of ants leading us at this point in time? Well, upwards and onwards as far as we can tell for the moment.

In an article not too long ago we shared some observations about the number of companies participating in the ongoing stock market rally. At the time we noted that the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) appeared bullish as always but fewer stocks seemed to be participating in the rally.

The number of stocks participating in a stock market move is a good measure for investor sentiment. Positive sentiment typically leads to a large number of stocks participating in a rally, and decreasing participation is often seen as an early sign for an onset of a more cautious sentiment among investors that can potentially put an end to the rally.

Participation is best illustrated using the so-called tool of the "Advance/Decline Line" which effectively counts the number of advancing stocks and deducts the number of declining stocks within a given trading period. At the time we observed that a plateau was forming in this A/D-line for stocks listed on the NYSE while the SPY was still motoring upwards. We suggested that a break of this plateau was needed to confirm a continuation of the bull market.

A couple of weeks on from these observations and sentiment certainly seems to have picked up again. SPY is still registering all-time highs; and participation has picked up again and has broken through the plateau shown as a purple line in the chart below.

These observations indicate increased investor confidence to us. A greater number of stocks is enjoying the blessings of positive investor sentiment and the tide is carrying an increasing number of ships. We interpret this observation as a bullish indicator for the stock market. For this interpretation of sentiment to hold up the support line in the chart above needs to remain intact. So far this support has been tested twice; call it a couple of sticks that have been run through the proverbial line of ants...

And What Does It Mean For Gold?

Like last time we ask this question at the end of our article. As most of our readers will know, we have a soft spot for gold-related investments (NYSEARCA:GLD) and feel most comfortable trading the related instruments.

At this point in time we believe that some of money invested in the stock market is money moving away from the gold-space. And while the stock market seems to be marching on undeterredly, we are likely to see more weakness in the precious metals. Sentiment among gold and silver investors is decidedly bearish and we see a high probability of GLD testing June lows again.

Gold closing below $1,240/oz (or $119.5 in GLD terms) would convince us to initiate a short position. For traders sharing this view we suggest considering a position in ProShares UltraShort Gold ETF (NYSEARCA:GLL). This ETF tracks twice the inverse of daily paper gold. Due to the leverage it is quite a volatile instrument and we recommend careful usage of stops to avoid hefty losses should the trade not work as planned.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.